A flash in the pan, or the shape of things to come? The issue of shareholder activism is now squarely on the agenda for Australian business.
Australian institutions have historically preferred to operate behind the scenes, rather than emulating their US counterparts and engaging in public stoushes with boards and management. Late 2013 saw a major break from that tradition, when Perpetual acting with Mark Carnegie took a very public stance on the longstanding cross-holdings between Brickworks and Soul Patts.
There have already been comments that we can expect much more of this type of public activity in Australia.
In part, of course, those comments reflect the fact that we live in a world in which US business practices often become global ones. Nevertheless, it is important to bear in mind that Australia has a quite different regulatory environment from the US. That's not to say that institutional shareholder activism could not become a part of Australian business. Before it does so, however, it will have to come to grips with the relevant law.
As we detail in this two-part primer, the legal matrix of the Corporations Act and case law is a complex one, but one which, if understood and negotiated, offers opportunities and presents challenges to both activist shareholders and targeted boards.
The Two Strikes Rule
Institutions have undoubtedly been emboldened by the Two Strikes Rule.
Many critics have said that the Two Strikes Rules is otiose, since the Corporations Act already provides shareholders with the ability (through a requisitioned meeting – see below) to change company boards. However, the Two Strikes Rule has several advantages for activists, particularly institutions.
The first is that it doesn’t actually require activists to do anything. Courtesy of the Corporations Act, activists are given an annual opportunity to put pressure on boards without having to go to the trouble of requisitioning a meeting.
By removing the need to requisition a meeting or draft a spill resolution, the Two Strikes Rule also means that more conservative institutions don’t have to take a very public lead in attacking an incumbent board.
Of course, the real benefit of the Two Strikes Rule is that it’s largely a Claytons spill motion. The low threshold for the remuneration vote ensures that shareholders can put the board under pressure to respond to shareholder concerns (or to head off them off before the AGM) without having to press the button on the blunt (and potentially value-destructive) weapon of a complete board spill.
Another factor which is encouraging shareholder activism is another import from the USA – proxy advisers. There are many valid concerns about proxy advisers and their agendas. Nevertheless, there can be little doubt that they do provide a collective focus for investor concerns.
Division of powers – The NRMA case and its aftermath
One of the major barriers to shareholder activism in Australia is the NRMA principle. In brief, this says that shareholders cannot tell directors how to run their company (unless, the company’s constitution explicitly gives such power to the shareholders).
The principle was born out of one of the first modern corporate activist campaigns in Australia – the long-running battle for control of the board of the National Roads and Motorists Association. In the lead-up to the Association’s 1986 AGM, a number of members requisitioned a general meeting to consider two motions: one to direct the board to appoint a named returning officer for the board elections and the other to direct that returning officer to use a particular balloting method.
The Association successfully asked the NSW Supreme Court to order that the requisitioned meeting not be held.
The Association’s constitution (like that of most public companies) gave the board “the control and management of the business and affairs of the Association”. The Court held that this meant that the members had no power to direct the board on how elections were to be conducted. Since the proposed resolutions could therefore have no effect, it followed that the company did not have to convene the requisitioned meeting to consider them.
That holding was not unexpected, since it was based on earlier judicial authorities. What made the NRMA case stand out was the requisitioning members’ alternative argument.
Effectively conceding that they could not force the board to conduct the election in a particular way, they argued that the requisitioned meeting could still be held to consider resolutions in which the members expressed only their opinion about how the election should be held.
The Court denied them even that solace, in what constituted a new legal principle:
“[I]t is no part of the function of the members of a company in general meeting by resolution, ie. as a formal act of the company, to express an opinion as to how a power vested by the constitution of the company in some other body or person ought to be exercised by that other body or person… The members of the plaintiff no doubt have a legitimate interest in how these powers are exercised, but in their organic capacity in general meeting they have no part to play in the actual exercise of the powers.”
No authority was cited for this novel proposition, which was undoubtedly welcomed by incumbent board members across Australia.
Although it may have been legally debatable, barring members from formally expressing views about how their company was run also neatly avoided a more serious issue: would directors be in breach of their duty to the company if they ignored a shareholder vote about how the company should be run?
(Interestingly, there appears to have been little debate about the fact that the Takeovers Panel’s frustrating action policy appears to contradict the NRMA case. That policy requires boards to submit business decisions to general meetings and effectively requires boards to follow the decisions of those meetings, even if the boards do not consider the result to be in the company’s best interests. This is however limited to decisions which would cause takeover bids to fail and it is a well-accepted principle in Australia that shareholders, not directors, should have the ability to determine whether a takeover bid should proceed.)
The NRMA principle effectively closed off one avenue for shareholder activism. However, the judge’s reasons also indicated that there was an alternative route (although not one which the NRMA activists had actually taken):
“As I see the matter, the only power vested in a general meeting of members which might be available to attain the object set out in the requisitions would be the passing of a special resolution altering the Articles of Association appropriately.”
This hint was then enthusiastically taken up by the next wave of shareholder activists. Instead of requisitioning meetings to direct the board to adopt a particular policy, they requisitioned meetings to amend company constitutions to incorporate the policy.
This tactic suffered from two problems.
The first was that a motion to amend a company’s constitution requires a 75% vote in favour. Where the motion is being proposed by environmental or social activists and the target is a major listed company, there is little likelihood that it will come close to achieving 75% acceptance at a general meeting. The experience of GetUp at the 2012 Woolworths annual general meeting is typical: GetUp’s proposal to amend Woolworths’s constitution to restrict the use of poker machines in its business was supported by only 2.5% of the votes cast.
The second problem with trying to amend constitutions to achieve activist policy outcomes was section 136(3) of the Corporations Act. This says that, in addition to requiring a 75% vote, a change to a constitution can be made subject to additional requirements in the constitution itself. As shareholder activism ramped up in the 2000s, Clayton Utz drafted a section 136(3) clause for clients to consider adopting in their constitutions. A typical clause read as follows:
“A special resolution to modify or repeal the Constitution of the Company, or a provision of the Constitution of the Company must, prior to notice of the meeting of Members at which the special resolution is to be considered, being given to Members, either:
(i) have been approved by a resolution of the Board; or
(ii) have been proposed by Members with at least 5% of the votes that may be cast on the resolution.”
This clause was aimed at a specific mischief caused by section 249D(1), which allowed general meetings to be requisitioned by either members holding at least 5% of the votes in the company or at least 100 members. Activist groups had adopted the tactic of acquiring a small parcel of shares (usually considerably less than 5%) and then splitting it among 100 fellow-travellers in order to get the 100 members necessary to requisition a meeting.
Since activist agendas generally tended to be overwhelmingly rejected at general meetings, the purpose of our section 136(3) clause was twofold: to save the company money, by heading off the need for a pointless meeting; and to deny activists the use of a general meeting as a forum for their agenda.
Incidentally one of our clients did include the section 136(3) clause in its constitution which not surprisingly drew significant criticism from the shareholder lobbyists including the Australian Shareholders’ Association.
Together, these developments greatly reduced the use of requisitioned meetings to promote social and environmental agendas.
However, in the new paradigm, where shareholder activism is business-focused and driven by significant institutional investors, section 136(3) clauses offer little protection to companies, since the current crop of shareholder activists usually have no difficulty in amassing 5% of the voting power in the company. Nevertheless, they do still face the barrier of the NRMA case. Unlike their predecessors, they have generally eschewed the constitutional change option, not only because of the high threshold for changing the constitution, but because their business objectives cannot easily be shoehorned into the form of a short amendment to the constitution.
That leaves them with the option of requisitioning a meeting to change the board, in whole or in part.
While this tactic is fairly common among smaller listed companies, it is still relatively rare among larger companies. However, when it is used, it can be difficult for a board to deal with, due to what is known as the Advance Bank case, which we'll consider in the next edition.